Sahm Adrangi’s Kerrisdale Capital Long Case For Webster Financial

Disclosure: We are long shares of Webster Financial. Please review our disclosures at the end of our email.

We are long shares of Webster Financial (WBS). Our full 44-page report is available here.

We also issued a letter to the company this morning encouraging management and the board of directors to explore strategic options to highlight the value of HSA Bank, including a potential spin-off of the asset.

Additionally, we will host in-person meetings on March 5th and 6th in New York to discuss our views with interested investors. Please contact myself and Theresa Callahan at tcallahan@kerrisdalecap.com if you would be interested in attending these meetings.

Webster Financial is a mid-sized regional bank holding an undiscovered multi-billion-dollar asset. On the surface, Webster is just another depository, albeit one with leading market share in Connecticut and surrounding areas. Despite consistently strong performance, including positive operating leverage and robust loan growth, Webster trades in line with its less impressive peers at 15x consensus 2015 earnings. Simply based on traditional banking metrics, Webster’s valuation is too cheap. But what truly makes Webster special is its HSA Bank unit, which, in the wake of its recently closed acquisition of a similar operation from JPMorgan, is now the nation’s largest provider of health savings accounts. These HSAs — tax-advantaged deposits tied to high-deductible health plans and used to pay for a wide range of qualified medical expenses — have exploded in popularity as employers and policy-makers search for ways to restrain health spending. HSA Bank has been at the forefront of this trend, growing its deposits organically at a 29% CAGR since 2005; today, with more than $4 billion under management and approximately 15% market share in a sector that is forecast to more than triple in size over the next several years, HSA Bank is poised for even greater success.

Investors recognize HSA Bank’s attractive growth prospects and unique value qualitatively, but have failed to recognize the magnitude of the upside. Making matters worse, Webster’s financial disclosures, though improving, have made it difficult to observe the HSA segment’s profitability directly. Fortunately, there is now a very clear comparable: last July, an HSA Bank competitor called HealthEquity (HQY), which is roughly half HSA Bank’s size, went public and has now garnered a $1 billion valuation. Scaling this valuation based on a variety of metrics, we estimate that HSA Bank could easily trade for $2 billion. Given Webster’s overall market cap of only $3 billion, shareholders are in effect getting the core regional bank – with $14 billion of loans and deposits and a mid-teens return on tangible common equity – at an incredible discount. To our knowledge, almost no one else has undertaken this simple analysis; indeed, few are even aware of HealthEquity’s existence, despite its obvious relevance.

Sahm Adrangi’s Kerrisdale Capital: Webster should spin off HSA Bank

Going further, we pull together the available information about the pro forma HSA Bank’s earnings power and, making straightforward assumptions, estimate a standalone DCF value of almost $17 per share. Using conservative peer multiples for the core bank, we value the combined business at $46, 34% above the current stock price. To cure the dramatic undervaluation of Webster’s solid, well-run regional franchise and high-growth HSA business, we urge the company’s board to consider a simple prescription: spinning off HSA Bank.

Sahm Adrangi

Kerrisdale Capital Management, LLC

About

Kerrisdale Capital is a value-oriented and special situations investment manager based in New York.